This paper builds a theoretical model and studies the optimal risk management of central counterparties (CCPs). Depending on the prevailing type of default in the trading environment, a welfare maximizing CCP adopts different combinations of risk management tools. If default is strategic, clearing fee, on top of margin and default fund, is necessary to achieve equilibrium and a higher margin or default fund improves welfare. However, if default is forced, equilibrium can be achieved without clearing fee and welfare is U-shape in margin: welfare first decreases and then increases in margin.
Keywords: Central counterparties, counterparty risk, risk management